Convert and sell inherited house into flats - how to avoid tax?

[TiTiH]

Hi all, first post here. I am indeed a noob in the property market too, so assume I know very little ;)

I'm sole inheritor of a 3 bed house which has an outstanding mortgage of £16K. It's in bad need of renovation and the similar house next door has been converted into 2 flats so I may as well go for a conversion.

I'm intending to remortgage for enough cash to renovate and convert and wanting an easy life, selling the 2 flats rather than keep them for rental. I intend to transfer deeds to both mine and my partner's name.

The market value of the house (and indeed total estate) even after renovation would be less the IHT threshold so I know I won't have to pay IHT.

Let's throw some very rough figures at you:

Current value (assuming no work needed): £200K
O/S Mortgage: £16K
Conversion/renovation budget: £60K
Estimated market value of flats once converted: £150K x2 = £300K.

Now, if the combined selling price for the 2 flats goes over the IHT threshold - do I become liable?
Even if I've spent £60K converting them?
What about CGT? Does that come into the equation, if so how can I avoid or minimise it?

Any advice at all would be appreciated. I can give more specific info if needed.

Thanks in advance!

[Tax Accountant]

Hi,

You are not concerned about the IHT position of the deceased. However, as you say, the total estate value is below the IHT threshold and therefore there is no IHT to pay by the estate.

Now coming over to you, you inherit the house at the estate value for CGT purposes. You are not concerned with IHT at all.

If the estate value of the house is £200,000, and you spend say £60,000, your total base cost of the property for CGT purposes will be £260,000. If you then sell for £300,000, your gross gain will be £40,000. You will only be entitled to annual CGT allowance of approx £10,000, leaving £30,000 to be added to your other taxable income and gains in the year of disposal. Therefore, depending on your other taxable income and gains in the year of disposal, the gains on the sale of the flats may take you into higher rate and be taxed at 40%. To the extent any of the gains is contained within the basic rate band, that amout of the gains will be taxed at the lower CGT rate of 20% and only so much as falling into the higher rate band will be taxed at 40%.

As to mitigation:

(1) Consider deed of variation of the will of the deceased so that the house is left to you and your partner in equal shares.

(2) Alternatively, consider transfering the house into joint names with your partner before renovating it.

(3) Ideally, once the renovation is completed, you and your partner should occupy the flats as your main residence. There will be a possibility of occupying it as your residence and nominating it as your main residence for CGT purposes.

(4) Consider letting it for at least a short period to avoid any possibility of being treated as a property developer and being brought into charge to Income Tax and NIC rather than the more favourable CGT.

(5) Consider selling one flat in one tax year and the other in the following tax year to obtain benefit of two annual CGT allowances.

Finally, it is important that you take professional advice before proceeding as your situation involves a number of issues.

Ramnik

[TiTiH]

Thanks for a comprehensive answer.:D

[Tax Accountant]

Thanks for a comprehensive answer.:D
You are welcome.

Ramnik

[Grange]

(4) Consider letting it for at least a short period to avoid any possibility of being treated as a property developer and being brought into charge to Income Tax and NIC rather than the more favourable CGT.



I would go further than that and say that your proposal gives a high risk of being treated as a property developer - or of being caught for incmoe tax by other anti-avoidance measures.

Could you go to live in one of the flats for a year or so - that would save you quite a bit of CGT.

Bear in mind that if you do sell the two flats separately there are practical issues regarding the freehold. Whilst selling them in separate years may be attractive for CGT purposes, it can be hard to arrange sales in different years, and you will then become the freeholder of a block of flats.

Will you get planning permission to do this conversion?

[Tax Accountant]

I would go further than that and say that your proposal gives a high risk of being treated as a property developer - or of being caught for incmoe tax by other anti-avoidance measures.

Could you go to live in one of the flats for a year or so - that would save you quite a bit of CGT.

Bear in mind that if you do sell the two flats separately there are practical issues regarding the freehold. Whilst selling them in separate years may be attractive for CGT purposes, it can be hard to arrange sales in different years, and you will then become the freeholder of a block of flats.

Will you get planning permission to do this conversion?

Letting the flats for a while, rather than selling them immediately, will give you a lower risk of being treated as a property developer than would be the case otherwise.

The actual level of risk is dependent on a number of factors, including whether your occupation is in the property trade.

As to making the flats your residence, this is already covered in my original reply.

Without planning permission, the question of conversion will not even arise in the first place.

If the property is converted into two flats, a freehold interest will need to be created in any case, regardless of whether the flats are sold in one year or in two separate tax years. I don't see why it would be harder to sell in two different tax years than in one tax year.

Ramnik

[Grange]

I don't see why it would be harder to sell in two different tax years than in one tax year.

You have obviously never tried to sell a property... I was making a few brain-storming suggestions from a commercial point of view, nothing more.


a freehold interest will need to be created in any case,

That'd be clever!

[Tax Accountant]

You have obviously never tried to sell a property...

Bearing in mind that we are talking about two separate leasehold flats, I still don't see why it is more difficult to sell them in different tax years than in the same tax year.

If anything, I would have thought that it would be easier to stagger the sales over the two years rather than putting them both on the market at the same time.

But as you say, what do I know about looking into the crystal ball. Good job I didn't become an Estate Agent.

Ramnik